Mortgages and the state of nature

David Wessel had a good column this week on the role government supports play in creating our culture of homeownership. In particular, he points out the economic absurdity of the 30-year, fixed-rate, no prepayment-penalty mortgage, which Raj Date once memorably described to me as a loan that "does not flourish in the state of nature."

In about the clearest description I've read of the 30-year fixed rate, Wessel quotes Patrick Lawler, chief economist of the agency that regulates Fannie Mae and Freddie Mac, saying that "people who take a 30-year fixed-rate mortgage are buying a two-fer: a loan plus the right to prepay without penalty. You might call it a derivative that protects the borrower. Rates fall, you refinance; rates rise, you don't pay 'em." The only reason these mortgages survive is that the government subsidizes them.

The question, as always, is why we do that, and whether we should continue. Homeownership is supposed to promote a lot of civic virtues like caring for your property and voting in local elections. But there's a correlation/causation problem there: Because we support homeownership so heavily, people who are going to be in one place for a while strain to own homes. If we had a culture of long-term renting, as many other countries (and many cities) do, you'd see more of those behaviors, which speak to being rooted in a place, in renters.

And then there's the question of encouraging people to lock themselves into a place. You're seeing the downsides of that in this recession, where there are plenty of homeowners who live in recession-battered areas, can't sell their homes because no one wants to buy, and so can't move to places with more economic opportunity. This is an outcome we have explicitly encouraged through an enormous raft of costly, regressive policies. And though the politics of taking these subsidies away from people who currently have them might be impossible, the politics of taking them away from future homeowners might be better, particularly if framed in terms of ridding ourselves of Fannie Mae and Freddie Mac.

I think a bad economy with low unemployment rates lock people into place.

Most people I've ever talked to who bought 30 year, fixed rate mortgages, planned to sell their homes after about 5 years. Most people traditionally don't think of these loans as something that will lock them into place.

That said, I never buy a house without being willing to stay in that house forever--in case the housing market crashes and I have no chance to sell or rent it out.

You can always find a buyer for your house, if you can afford to take a hit on the price. However, if you are underwater and you'll have to come up with $10,000 in cash to pay off your loan, once you sell it, you have no room to reduce the price.

Thus, being locked into your home and unable to move has a lot more to do with the nature of mortgages than it does with home ownership. I could sell my house tomorrow, in a down market with lots of folks trying to sell their houses, if I'd sell it for 30% below what I paid for it. However, if I had to come up with the cash to make up that difference, I wouldn't be able to pay of the existing mortgage to sell my house at a loss.

I think there's a certain amount of Monday-morning quarterbacking here. And a lot of it is the recession talking.

Can we separate the issue of home ownership from the current downturn, recent practices in lending, sociological changes in the demographics of our citizenry, nineties and aughts redefinition of home ownership as investment rather than shelter, etc.?

There's nothing wrong with owning a home. Any of us who have been renters can attest to landlord problems, the inability to make changes to your residence, lack of outdoor space, etc. People like to own homes because they are theirs, and they don't have to answer to anybody. Some things have changed over time, however. When you bought a home in previous eras you were very likely to stay in it for a decent period of time, perhaps even the entire 30-year term of the mortgage. Then you lived mortgage-free during your retirement years. That has changed because of a general increase in mobility (for job or personal reasons) and because people started buying homes as stepping stones or as investment opportunities to flip. And then there were the shockingly bad lending practices of the Bush years. And let's not forget what hasn't been talked about much: a real-estate industry with less than satisfactorily regulated practices.

There's nothing wrong with renting, and there's nothing wrong with the aspiration to home ownership. Not everyone wants to or is able to own a home. But let's not throw the baby out with the bath water.

It takes a really, really long time to build up any equity with this kind of mortgage, so I don't know that it's such a great deal for the buyer.

But on the other hand, I do think the mortgage interest deduction should be phased out. It inflates housing values (you see how well that worked out!) and contributes to further inequities in school funding.

The idea that 30 year mortgage don't exist in nature is a bad attempt to malign the role that Freddie and Fannie have in the market. The average life of a mortgage is about 7 years typically due to relocation (that's why mortgage rates align with 10 year treasuries). Lenders can make plenty of money creating these loans and refinancing them because of the secondary market the Freddie and Fannie helped start.

In fact, it was the purely private sector that devised magical schemes to reduce risks by consolidation bad loans with good one so the private sector could lend money with few standards. As you point, Freddie and Fannie were late to a game that they never should have joined.

Yeah, I don't know anyone who owns a home that is locked into a place *because* of home ownership. More common is that people *like* where they're living, or it's where their family lives, or it's where they grew up, or it's where their kids go to school.

As someone who's trying to plan a move across the country (Goodbye, NJ, hello again WA!), there are lots of things that make it difficult. Not being able to sell a home may be one of the things that keep people grounded, but it's not like most home owners are just itching to pull up stakes at a moment's notice.

What I've never understood about the pro-renting argument is that there's literally no investment in renting. Renting would have to be some amount cheaper than owning a home that the renter could take the difference between their rent and the mortgage holder's mortgage payment, invest it, and come out ahead in the long term on the value of their investment (the money) and the mortgage holder's (the house). I was never great at math, but I'd imagine that the rent would have to be fairly significantly cheaper to make that work.

Also, the rent will never go down over time; it will only go up. Furthermore, it never ends. While a mortgage gets paid off eventually, the renter will be paying more and more until their dying day. Meanwhile, the mortgage holder can refinance after 5, 10, 15, or 20 years and drastically reduce their mortgage payments. Then they might be paying as much or less than the renter per month and investing the difference.

Finally, the renter is pretty much stuck in what they can afford. They get the best place they can afford and invest the rest. A mortgage holder, on the other hand, gets the best house they can. Ten years down the road, however, the renter is still paying as much rent, if not more, and also has some amount invested, while the mortgage holder has a significant investment in their house. Now, maybe the renter has saved enough that the investment itself is earning enough money to allow them to upgrade to a larger house, but that seems doubtful. The mortgage holder, however, can sell their house and get something bigger, say to accomodate a larger family, and still pay the same amount they were paying before.

To sum it up in the more common formulation: Mortgage payments are an investment. Rent disappears. Maybe we can make rent cheap enough that it's a better deal than owning, but I've never seen anyone make that case.

Neither you, nor Mr. Wessel, are persuasive on exactly what the harms of the thirty-year fixed mortgage are.

Yes, when the economy crashes and the government refuses to apply a level of stimulus that the problem requires, then homeowners will be in a sucky situation. But the drivers of that situation are the crash (caused by huge institutions gambling with risk-hiding financial instruments, not by 30 year fixed rate loans), and the inability/unwillingness of our political institutions to respond to a crisis.

Other than that, I'm not sure what the problem is. They're not "natural," sure, but since when do liberals object to using government's influence to "protect borrowers"? That sounds like a good thing.

"And though the politics of taking these subsidies away from people who currently have them might be impossible, the politics of taking them away from future homeowners might be better, particularly if framed in terms of ridding ourselves of Fannie Mae and Freddie Mac."

Dang dude. Our generation is going to have to pay significantly higher taxes and accept a significantly lower level of public services. I get that this is almost entirely due to George W. Bush's bad management and the awful recession, but our current crop of pols refuses to raise taxes or seriously make the military or entitlement cuts necessary. Our employment horizon is also significantly worse than our parents' prospects, with the most "responsible" analysts and pundits telling us to just get used to high structural unemployment rates. Those of us who are recent graduates will likely spend the first 10 years of our careers barely scraping by between high student loan debt, significantly diminished wages, and cutthroat competition.

And now you want to take away the homeowner tax exemption "but only going forward?" I can basically understand and come to terms with a lot of the crappy hand our generation has been dealt, but don't balance the budget on our backs just because existing homeowners would whine too loudly. There is something seriously screwed up in a political system where Medicare and Social Security are untouchable holy grails, but the main asset-building policy for young people is totally up for grabs.

Subsidies. Is there a chart like the stimulus money chart that shows the relative benefits of subsidies across industries like agriculture,big oil, etc.? When do subsidies turn a free market into a rigged market?

The first question seems to involve resolution of the tautology: is home ownership a good thing or a bad thing? More specifically, is it better for someone to buy a home, with its civic virtues, or a pound of crack, with its civic virtues?

Simple question: Dollar for Medicaid and pound of crack or dollar for mortgage exemption, children in [costly] school, and a stable community? Which would liberal Social-Democrats prefer? Pick only one!

First, Date is wrong. Subprime PLS loans (which did not go through the GSEs) were often fixed rate 20-30 year loans. The ones in the late 1990s almost always were fixed rate. So, the financial sector can deal with fixed rates without the GSEs (though they did it abusively). This is what CMOs helped do by piecing out interest rate risk. It was done both in the agency and PLS markets.

Second, "State of nature"? We are resorting to natural law to propose policy? Get real. No institutional mortgage works without a whole lot of public sector infrastructure, like mortgage law, etc.

The 30 year fixed rate mortgage - which generally has had a stellar history in terms of loan performance -- shifted interest rate risk away from folks who were highly vulnerable to it. The explosion of ARMS and other nontraditional products is directly linked to high foreclosure rates.

Is it better for the financial sector and/or government to absorb interest rate risk rather than homeowners? By the way, in the priUnequivocally YES. The government can charge for absorbing this risk after all. It is better to have slightly higher fixed rates than lower ARMs that increase foreclosure and systemic risk.

I find it hard to believe that you are calling for a move to ARMs as a risk-reducing measure. And please don't resort to international comparisons. There are all sorts of other things going on in those markets that can't be easily controlled for - like massive subsidies to social housing and rent control. Things that will not happen here.

i notice rmgregory isn't even trying to make sense, but let's help out NS12345.

young person, i hate to be the one to break it to you: the tax break you get on your mortgage interest isn't worth anything to you.

that is, the seller knows it exists. as a result, the seller simply raises his price so that it normalizes: you are going to pay the same amount after-tax regardless of whether you get a tax break or not.

(hmm, maybe that's not clear, so let's put it this way. you can afford, let us say, a $1500 mortgage payment after taxes. now, if there is a tax break, what you will pay is higher than $1500/month - it'll simply net back out there. so when that translates into a house price, it'll be a higher house price than it would be if there was no tax break and you were simply paying $1500 out of after-tax income, but from your perspective, you can't afford more house - the house you could afford became more expensive on paper.)

kevin willis: please. you must know better. when supply outstrips demand (as it does in a number of locations around the country), then even making your price zero doesn't find you a buyer. there aren't enough buyers to be found in some areas.

so no, there isn't always a price at which you can sell no matter what if you're willing to take the hit on your asset value.

This is tangential, but it's been bugging me for a while: are the only people who believe in the existence of the perfectly free flow of labor economists and childless 20-somethings? Once you start accumulating "stuff," moving becomes an enormous pain. To blithely say that except for factor X, labor could freely move seems to me to be either a function of insufficient life experience or a degree in freshwater economics. And Ezra is far from the biggest offender [*cough* Yglesias *cough*].

I think this argument overlooks the facts of actual housing stock. Is everybody going to live in rented FEMA trailers that can be moved to "where the jobs are"?

Furthermore, how do the free market interests of landlords play into this? Say you have a wealthy landlord in an area with a large military contractor producing overpriced and useless weapons systems (it could happen!). It's better for the country as a whole and the federal budget to cut funding. The local congressional delegation doesn't want to lose jobs. Have you stayed with this hypothetical? Now you're going to throw into this mix the wealthy landlord's self-advocacy? This landlord is looking at his facilities becoming worthless!

Ezra, please do another post including Detroit's experience with excess housing stock in a further analysis.